[Reuters Analysis] Long bond blues stress the 'bedrock': Mike Dolan

By Mike Dolan

LONDON, May 27 (Reuters) - Bonds had a bruising week recently and investor aversion to long-dated government debt appears to be rising.

Anxiety over U.S. debts and deficits took center stage as President Donald Trump's fiscal bill passed the House of Representatives - potentially adding another $3.8 trillion to the $36 trillion debt pile over the coming decade.

But mountainous government debts across major economies and unpredictable inflation, amplified by unfolding trade wars, fuel uncertainty over the central bank interest rate horizon.

At the same time, central banks continue to reduce the huge holdings of government debt accumulated over the past 15 years, particularly during the pandemic.

This development requires private investors to take up the growing slack at a nervy time - many of whom are far more price-sensitive and more wary of long-duration bonds due to their greater sensitivity to changes in interest rates.

Many non-bank private investors embrace long-duration debt - such as pension and insurance funds that crave steady long-term income streams from relatively safe government credits in order to match their long-term liabilities.

Others, such as mutual funds or hedge funds, may be less willing to absorb outsized price risks at the long end.

And as exchange-traded funds that track long-term Treasuries show, it's been a dire few years.

The iShares ETF of U.S. Treasuries with remaining maturities of 20 years or more TLT.K is down another 3.5% for the year so far - almost as much as the loss in Wall Street's tech-heavy Nasdaq equity index .IXIC.

It has now halved in price since it peaked during the pandemic and is down 30% from the eve of the COVID-19 outbreak.

While "terming out" government debt to longer maturities has long been seen as a prudent practice to reduce roll-over risks with too much short-dated borrowing, it may now contain frailties of its own due to shifts in the investor base.

With economic and policy uncertainties rife, attention shifts toward private investor commitment and market stability.

MARKET BEDROCK

The International Monetary Fund last week highlighted potential risks to the functioning of government bond markets that policymakers need to address to protect what is called "the bedrock of capital markets."

In a piece that focused on liquidity risks and the smooth pricing of a market covering some $80 trillion of core government debt, it pointed out how bank dealers continue to play a critical role and have expanded sovereign bond holdings.

But it said that the rise in bank dealers' core sovereign debt had not kept pace with the growth of outstanding bonds.

The stock of U.S. Treasury securities grew nearly fourfold in the 15 years through 2023, for example, but U.S. bank-dealer balance sheets expanded by just 1.5 times.

Now, U.S. Treasury securities account for almost 70% of primary dealers' securities inventories - the highest share in over a decade - and about three-quarters of their securities financing is also collateralized by Treasuries.

"The challenge is that dealers' internal limits on concentrated holdings could curtail intermediation activities, especially in times of stress," the IMF blog noted.

That leaves the other non-bank financial institutions (NBFIs) to supplement the role of market makers.

"However, because they (NBFIs) have a generally weaker mandate to support government bond markets compared to bank-dealers, they may also quickly curb activities during times of market stress," the IMF piece said.

"The increasing presence of NBFIs makes market resilience more uncertain and opaque because they tend to be less regulated and subject to fewer data reporting requirements."

The IMF then goes on to urge governments to ensure more "structural resilience" via more central clearing, more timely, consistent and comprehensive data on market pricing and transactions and better information on NBFIs' soundness and reliability in times of stress.

To be sure, bond markets appear to be clearing well despite the outsize policy upheavals underway. But few doubt that there are difficult moments ahead and stress at the "bedrock" could be seismic.

The opinions expressed here are those of the author, a columnist for Reuters

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